Factors that affect creditworthiness
Overview
When an individual or business entity applies for credit, the lender has to do its due diligence by ensuring that they measure the risk of potential default by checking the credit status of the applicant beforehand.
This process typically involves an assessment of creditworthiness. In other words, what is the likelihood of a person or company defaulting on loan repayments? How reliable is the loan applicant?
In order for a lender to assess the level of creditworthiness, there are a number of factors that must be taken into consideration before any decisions are made. Factors include financial ability to repay the loan, the conditions prevailing at the time as well as the amount of credit utilised.
The right decision must be made and that the lender should not contribute to over-indebtedness.
The 5Cs are one of the most popular methods used to assess how creditworthy an individual or company is.
Capacity is a measure of financial ability. A comparison is made between income and current debt. If an individual has more discretionary income available, this means that they may be more likely to be able to afford credit.
An assessment of character indicates the trustworthiness of a credit applicant. It’s important to ask questions relating to how reliable they are. It’s essentially an assessment of borrower behaviour. For instance, do they pay on time? How do they use credit?
Under particular economic conditions, lending institutions may be less likely to offer credit. How much of a risk will the lender be taking by providing credit? If the risk is too high, then this has a negative effect of creditworthiness.
The level of credit usage is assessed by the amount of debt you have. If an individual has numerous loans to their name, then this increases the likelihood of them being unable to afford additional loan repayments.
Understanding factors that affect creditworthiness can go a long way towards finding ways to improve credit standing before credit applications are made.
